Retirement plans can pose special problems in estate planning. In part this is because retirement plans have complicated rules for contributions and distributions, penalties for early withdrawals and excess accumulations, and unique requirements when a trust is structured to receive or pass through retire plan distributions. Another reason retirement plans are unique is that taxes are a primary concern, because a decedent’s retirement account may be subject to federal and state income as well as federal and state estate taxes. Taxes on a decedent’s retirement plan can often amount to 70 – 80 percent of the account value. A third reason is that there are different regulations for retirement plans depending on whether the plan is a Traditional Individual Retirement Account (IRA), a Roth IRA, or a Qualified Plan. To compound matters, for many people, retirement plans are their largest or second largest asset.
Despite these complicating factors, there is tremendous opportunity to leave your spouse and children, or anyone else, a tax-advantaged account that can be a lifelong source of income. Planning in advance is essential to avoid some of the most common mistakes.
Mistakes Are Expensive
Mistakes include failing to minimize and delay taxes, exposing retirement plan funds to creditors and predators (including your children’s divorcing spouses), inadvertently disinheriting your children, and requiring your surviving spouse to make difficult decisions that they are not prepared for.
Benefits of Planning for Retirement Accounts
Advance planning greatly benefits your beneficiaries by (1) minimizing Required Minimum Distributions so that the plan’s tax deferral benefits are maximized, (2) providing asset protection to funds in the retirement plan against your beneficiaries’ creditors and predators, and (3) ensuring that the plan assets pass to your chosen beneficiaries and are not misdirected to opportunists preying on your surviving spouse.
NEET offers comprehensive estate planning for retirement plan accounts, including determining proper beneficiary designations, establishing trusts to stretch out plan distributions and provide asset protection, counseling on the different regulations applicable to IRAs, Roth IRAs and Qualified Plans, and properly integrating your retirement plan assets with the other elements of your estate plan. To learn more about your options regarding retirement plans, please call NEET to schedule an appointment.
FAQs – General
What is a Plan Administrator or Plan Custodian?
A Plan Administrator or Plan Custodian is the financial institution, often a brokerage firm, that administers the retirement plan for the owner.
What is a Designated Beneficiary (DB)?
A Designated Beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after the owner dies. Beneficiaries of a Traditional IRA must include in their gross income any taxable distributions they receive. A trust cannot be a designated beneficiary even if it is a named beneficiary, but the beneficiaries of a trust will be treated as having been designated as beneficiaries if certain trust requirements are met.
What is a Beneficiary Designation Form?
The Beneficiary Designation Form is used by the plan owner to designate the beneficiary of the plan if the owner dies.
What is a Required Minimum Distribution (RMD)?
The RMD, also called Minimum Required Distributions (MRD), represents the minimum amount that must be distributed from a retirement plan in certain situations, for instance if a Traditional IRA owner has turned 70 ½ and therefore must begin taking distributions. Failing to take an RMD results in stiff penalties, including the 50 percent excess accumulation penalty.
What is the IRA Account Balance?
The IRA Account Balance is the amount in the IRA at the end of the year preceding the year for which the Required Minimum Distribution is being figured. For determining the Required Minimum Distribution for a year, you divide the IRA account balance as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy.
What is the Required Beginning Date (RBD)?
The Required Beginning Date is the date you must start receiving distributions from an IRA. You must start receiving distributions by April 1 of the year following the year in which you reach age 70 1/2.
What is a Stretch IRA?
A Stretch IRA refers to a beneficiary’s ability to extend, or stretch out, the timeline for taking Required Minimum Distributions from a retirement plan. This defers taxes and results in greater account growth.
What Tax Penalties Can Be Assessed Against Retirement Plans?
There are four penalties associated with retirement plans: (1) a 10 percent penalty imposed on distributions taken before the owner turns 59 ½, with certain exceptions; (2) a 50 percent penalty imposed for excess accumulations, where the owner fails to withdraw the Minimum Required Distribution; (3) a 6 percent penalty imposed on excess contributions to an IRA; and (4) a prohibited transaction penalty that disqualifies an IRA and thus makes the account subject to income taxes immediately. Prohibited transactions include borrowing money from the plan, selling property to the plan, receiving unreasonable compensation for managing plan assets, using the plan as security for a loan, and buying property for personal use with plan assets, among others.
Can Retirement Plan Assets be Moved?
Retirement Plan assets may be transferred, tax free, to a Traditional IRA or a Roth IRA, subject to certain restrictions. Transfers are typically from one Plan Administrator to another Plan Administrator, a rollover of assets from one retirement plan to another, or a transfer incident to a divorce.
FAQs – Traditional IRAs
What is a Traditional IRA?
A Traditional IRA is usually a tax-deferred retirement plan, meaning that funds deposited to the plan and account earnings are income-tax deferred (pre-tax funds) until plan funds are distributed. Traditional IRAs are any IRA that is not a Roth IRA or a SIMPLE IRA, and include Simplified Employee Pension (SEP) Plans. Contributions to a Traditional IRA are deductible for income tax purposes, but distributions must begin annually after the owner turns 70 ½ years of age, at which time income taxes are assessed.
What Happens if the Traditional IRA Account Doesn’t Have a Beneficiary?
When a Traditional IRA does not have a Designated Beneficiary, or the beneficiary fails to qualify as a Designated Beneficiary, the result depends on whether the owner died before the owner’s Required Beginning Date (RBD) or after. If before, the entire plan balance must be distributed not later than December 31st of the calendar year containing the fifth year anniversary of the original owner’s death. If the owner died after their RBD, then the plan must make Required Minimum Distributions (RMD) based on the decedent’s anticipated life expectancy (contained in life expectancy tables developed by the IRS) had the decedent not died.
What Happens if the Spouse is Named as Beneficiary?
A surviving spouse may elect to: (1) cash the plan out and pay income taxes now; (2) elect inherited IRA treatment; (3) elect rollover of account treatment and make the IRA their own; or (4) disclaim the IRA and have it pass to the next listed beneficiary. There are important tax and income ramifications to each approach.
May a Trust Be Named as Beneficiary of a Traditional IRA?
A trust cannot be a Designated Beneficiary even if it is a named beneficiary, but the beneficiaries of a trust will be treated as having been designated as beneficiaries if certain trust requirements are met. If the trust is not properly structured and the trust beneficiaries do not qualify as Designated Beneficiaries, the mistake will likely have serious adverse financial impacts on the retirement plan.
FAQs – Roth IRAs
What is a Roth IRA?
A Roth IRA is a type of IRA where contributions are made after income taxes have been deducted. Because income taxes were removed before a Roth IRA deposit was made, distributions from a Roth IRA account are not subject to income taxes. An additional benefit of Roth IRAs is that there are never Required Minimum Distributions during the life of the original plan owner, and thus the plan may grow substantially and become a sizable inheritance for the Designated Beneficiaries.
What Happens if the Roth IRA Account Doesn’t Have a Beneficiary?
If a Roth IRA plan does not have a beneficiary and therefore ends up in the decedent’s probate estate, or the beneficiary fails to qualify as a Designated Beneficiary, the result is that the account must be paid out by December 31st of the calendar year containing the fifth year anniversary of the plan owner’s death.
May a Trust Be Named as Beneficiary of a Roth IRA?
A trust cannot be a Designated Beneficiary even if it is a named beneficiary, but the beneficiaries of a trust will be treated as having been designated as beneficiaries if certain trust requirements are met. If the trust is not properly structured, and the trust beneficiaries do not qualify as Designated Beneficiaries, the mistake will likely have serious adverse financial impacts on the retirement plan.
FAQs – Qualified Plans
What is a Qualified Plan?
A Qualified Plan is an alternative to IRAs, established by employers for their employees. Qualified Plans include Pension Plans, Profit Sharing Plans, 401(k) Plans, and 403(b) Plans. These plans are created under different laws than IRAs, and thus have different regulations governing them, as well as different features and benefits. Qualified Plans are often chosen by employers because employers receive a tax deduction for contributing to the plan, and like Traditional IRAs, employees do not pay income taxes on Qualified Plan contributions or earnings. Rather, Qualified Plans are taxed when distributions are made to the employee.
What Happens if the Qualified Plan Doesn’t Have a Beneficiary?
When a Qualified Plan does not have a Designated Beneficiary, or the beneficiary fails to qualify as a Designated Beneficiary, the result is similar to a Traditional IRA. If the plan owner died before the owner’s Required Beginning Date (RBD), the entire plan balance must be distributed not later than December 31st of the calendar year containing the fifth year anniversary of the owner’s death. If the owner died after their RBD, then the plan must make Required Minimum Distributions (RMD) based on the decedent’s anticipated life expectancy (contained in life expectancy tables developed by the IRS) had the decedent not died.
What Happens if the Spouse is Named as Beneficiary?
A surviving spouse may elect to: (1) cash the plan out and pay income taxes now; (2) elect inherited IRA treatment; (3) elect rollover of plan treatment and make the IRA their own; or (4) disclaim the Qualified Plan and have it pass to the next listed beneficiary. There are important tax and income ramifications to each approach.
May a Trust Be Named as Beneficiary of a Qualified Account?
A trust cannot be a Designated Beneficiary even if it is a named beneficiary, but the beneficiaries of a trust will be treated as having been designated as beneficiaries if certain trust requirements are met. If the trust is not properly structured, and the trust beneficiaries do not qualify as Designated Beneficiaries, the mistake will likely have serious adverse financial impacts on the retirement account.
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